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In its brief 22-month history, video-sharing site YouTube has become a cultural phenomenon. The Iraq War has been called the “YouTube War” because of the videos that are regularly uploaded by soldiers and insurgents. The upcoming U.S. presidential race has been called the “YouTube Election” with its own “YouTube Debates” thanks to the questions for candidates uploaded by the YouTube community of amateur video producers.

While the site was sold to search giant Google for an eye-popping $1.6 billion in November 2006 there’s still one thing it hasn’t accomplished, by most people’s reckoning: profits. In order to be profitable, your revenues must exceed your costs, and that’s difficult to reach for a site that served up 2.5 billion videos in September 2007, according to comScore. Those video-serving costs, coupled with the legal cost of fighting a $1 billion copyright lawsuit from Viacom, makes it tough to get into the black.

And on the revenue side, YouTube and Google have been loathe to serve up pre-roll advertising that would run before you could see all those videos. Instead, they’ve taken a more measured approach, trying out overlay ads that run on a small percentage of videos by pre-screened “partner” producers. As with any other community or social networking site, YouTube must tread carefully when commericializing the site so that it doesn’t scare off video uploaders or watchers. Plus, it has to consider what content makes an appropriate context for ads, as many brand marketers are worried about being associated with freewheeling user-generated (or user-pirated) video.

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Ad overlay on YouTube partner video

Google itself has been shy about discussing YouTube’s road to profitability. Bear Sterns analyst Robert Peck found that YouTube brought in just $15 million in revenues for all of 2006. Since then YouTube has started its partner program (sharing ad revenues with chosen producers) and overlay advertisements that run on the bottom part of videos. Making money with YouTube is what Google CEO Eric Schmidt considered to be this year’s “big project,” according to an interview with Bloomberg TV last March.

“It’s more complicated than we anticipated,” Schmidt said during the interview. “It’s been more difficult to navigate through the very complicated business structures that the media companies have erected [for their video content].”

YouTube’s home page now has a big video ad in the upper right corner, a strip of “Promoted Videos” near the top of the page, and an animated ad that runs when you do searches. (My search for buying a car brought up a Toyota ad.) Plus there are various special advertiser contests on the site, including an elaborate New Year’s contest with Samsung.

Google spokesperson Danielle Brincko wouldn’t tell me what percentage of video streams now included overlay ads, but she did say that “millions of video views each week are earning revenue for partners in this program.” Brincko also provided this statement about Google’s view on making money with YouTube:

YouTube is the largest online video community in the world, and we are working closely with users and advertisers to figure out what works for this unique environment. In August, we launched the YouTube Marketing Platform including YouTube InVideo [overlay] ads. We have since announced an expanded user partner program and will continue to evolve the platform in the coming months. According to eMarketer, online video ad spend was expected to reach $775 million this year with an expected growth to $2.9 billion in 2010. That being said, there is a tremendous growth opportunity. If this were a baseball game, the industry would only be in the bottom of the first inning.

YouTube as Strategic Asset

Rival video services and analysts told me they agreed that these are early days for video ads, and for figuring out the perfect business model for making money with video-sharing sites. JD Lasica, a new media blogger and also CEO of media-sharing site Ourmedia (which recently merged with Outhink), told me via email that YouTube was likely years away from breaking even.

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JD Lasica

“The last figure I heard is that YouTube costs (bandwidth and staffing) was running on the order of $5 million a month, with revenues nowhere near that,” he said. “But if you look at YouTube as a strategic asset that fits nicely into Google’s ad-generation ecosystem, it’s clearly a win for Google. It’s not about surrounding all those YouTube videos with text ads. YouTube has value in other areas: as a sandbox to test out the next wave of Internet advertising; as a distribution platform for striking sponsorship partnerships with the major media companies; as a bridge to the mobile video web; as an entry point to television and Hollywood.”

Karsten Weide, an analyst at IDC who covers digital media and entertainment, helped put together an IDC report last summer titled, Social Networking Services in the U.S. — Popular, Yes, But How to Monetize Them?. He told me that TV advertising would move more quickly online to sites such as YouTube if marketers felt the content was “brand-safe.”

“A lot of advertising on television and cable television will go online, and these are brand advertisers, and they will put those ads into something similar to TV,” he said. “Sites such as YouTube have a tremendous amount of popularity and traffic. The popularity and traffic is what’s real about these social networks. What’s not so real is the money coming in. The problem is that user-generated content is just not ‘brand-safe’ inventory. If it’s unsafe and I run my ad against it, it could hurt my brand. That’s content that is illicit or stolen content, and if you’re Colgate or Kraft or GM, you don’t want your brand next to that content.”

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Karsten Weide

So YouTube has various challenges to deal with when it decides which content can have advertising. First, does the uploader and YouTube have the legal right to show that content? Second, is that content “brand-safe” so that it won’t scare off an advertiser? Brett Mitgang, CEO of rival video site Veoh, told me that brand advertisers are more comfortable with the mainstream content that runs on broadcast TV or radio.

“In any nascent advertising space, it’s about the performance of the ad and about control,” Mitgang said. “User-generated content becomes less scary if you know your ad won’t be on a video where someone is urinating on a pet. Or you just don’t want to be on any R-rated videos. The more we’re able to characterize and categorize user-generated content — and to say this particular [demographic] audience is watching that — then the advertisers become comfortable. And then you have to show that there’s a high clickthrough rate to the ads.”

Mitgang told me every video startup has its own goals and unique path to revenues and profitability. He noted that Veoh is less mature than YouTube, and has only started to see meaningful revenues this quarter. Mitgang expects the company to close in on profitability “toward the end of next year.”

Sussing Out Execs, Analysts

But what about YouTube? As a more popular site, it likely has more bandwidth costs, but also the chance to make more money on all those videos — if it can get over the legal and “brand-safe” marketing issues. Unlike the paid search text ads that are Google’s bread and butter, video ads are not easily produced by anyone. Most of the money for video advertising online will come from big-name advertisers who do TV ads and expect a clean experience for their ads and brand.

Along with MediaShift associate editor Jennifer Woodard Maderazo, I spent some time digging around for quotes from Google execs, research from financial analysts and blogger speculation as to how well YouTube was doing with its revenues over the past 14 months. The following is a sample of those findings:

October 3, 2006

“At monthly revenues of $5 million per month just for the main page, methinks that YouTube is already profitable and is probably trying to be coy about its financials, with its monthly bandwidth costs rumoured to be in the region of $1 million each month. Call me crazy, but that means that just with its main page alone, YouTube more than covers its bandwidth charge…of course, there are more to costs than that, but if those numbers are right, its revenue run rate is starting to look pretty, which is why [CEO Chad] Hurley said the site won’t need any more funding, though he wouldn’t say if the site is in the black.” — Ashkan Karbasfrooshan, writing a post at WatchMojo titled YouTube Is Wildly Profitable — No Doubts About It

October 4, 2006

“Is YouTube ‘wildly profitable’? If we take the adjusted numbers and add in expenses, the answer is certainly ‘No.’

Total Revenue is $4.65 million a month after sales costs and discounts
bq. Bandwidth/Hosting Costs: $3.9 million a month
bq. Salaries, G&A and other costs: $450,000 a month
bq. Profit = $300,000 a month or a net margin of about 6.4 percent.

That looks like YouTube may be breaking even, but we’ve been generous in revenue calculations and, perhaps, in the cost of people and operations. YouTube is probably still running in the red.” — Mitch Ratcliff, writing on ZDNet blog post, YouTube Wildly Profitable?

February 1, 2007

“While it was the first quarter that included results from YouTube, the video-sharing site acquired by Google last fall, company executives declined to give a figure for its revenue contribution. Analysts believe YouTube contributed negligible sales.” — Ben Charny in a MarketWatch story on Google’s first quarter earnings

March 13, 2007

“Investor optimism regarding YouTube was misplaced.Google is failing to do anything with YouTube.” — Global Equities Research analyst Trip Chowdhry told MarketWatch in a story, YouTube deal a bust for investors so far

May 3, 2007

“Susquehanna analyst Marianne Wolk recently wrote in a research note that she expected the site [YouTube] to split ad revenues evenly with content creators. She estimated that YouTube could generate $72 million in revenue in 2007, rising to $300 million in 2008.” — Alexandra Berzon, writing in YouTube’s Commerical Audition for Red Herring

July 23, 2007

“When considering Google acquisitions, YouTube is an instructive case. Google purchased YouTube for $1.6 billion, with the plan to turn the video giant’s eyeball share into cash. Google would just need to provide the right ad model. But more than half a year later, that ad model still seems far away. Omid Kordestani, Google’s senior vice president of global sales, said on last week’s earnings call that Google ‘still needs to prove [YouTube] to advertisers and publishers before we scale it,’ and that the Google team was on the case. How Google plans to ‘prove’ YouTube was left unanswered. Meanwhile, YouTube has brought Google a $1 billion lawsuit from Viacom.” — Mark Simon, writing MediaPost’s Search Insider blog post titled Google’s Shaky Investments

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Henry Blodget

August 21, 2007

“So, Google’s YouTube will finally sell video ads. How much revenue will they generate? Most likely, not enough to materially affect Google’s overall revenue for at least a year or two. Over the long haul, the contribution could be very material, at least on the top line.” — Henry Blodget, writing at Silicon Alley Reporter on a post called Analyzing YouTube’s Revenue Potential

A companion chart on Silicon Alley Insider lists current annual revenues at somewhere between $12 million and $360 million, with that rising to $180 million to $12.6 billion by 2012.

September 4, 2007

“Google decided to offer marketers a new type of ad that will appear in select videos. Users can click on the ads, which pauses the video and launches the commercial. Or they can ignore the ad, which will disappear in 10 seconds. So far, Google said, more people are clicking. Eileen Naughton, Google’s director of media platforms, said between five and 10 times as many people are checking out the in-video ads compared with the number who view regular display ads…Advertisers who have tried YouTube’s new program confirm Naughton’s numbers.” — Elise Ackerman, in a San Jose Mercury News article, New semitransparent ads click with YouTube users

October 10, 2007

“Unlike text ads, you can’t read the text and then click afterwards to get more information. Video is a different experience, more about entertainment than information gathering. It’s basically more of a passive medium.” — Gartner analyst Andrew Frank in a Forbes article, Making YouTube Pay Off

December 14, 2007

“Advances in the filtering, monitoring and targeting of online video are beginning to make user-generated content a less fearful proposition for advertisers, or so says Lehman Brothers analyst Doug Anmuth in his Internet Inside Weekly report. Anmuth’s take: In addition to those protections, the audience-size thresholds imposed by sites like YouTube and Metacafe will help provide a more ‘well lit’ and appealing environment for advertisers.” — David Kaplan, in a post on PaidContent

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What do you think about YouTube’s prospects for becoming a profitable division of Google? What are some of its roadblocks and when do you think it might become profitable? Share your thoughts in the comments below.

Additional research for this story by Jennifer Woodard Maderazo.